There’s nothing wrong with making a quick buck in the market–even if you’re a disciplined, long-term investor. Happily, Canada offers two compelling opportunities for a windfall. And best of all, the primary targets are income trusts paying big dividends backed by strong businesses, investments even the most conservative can buy and hold comfortably.

One opportunity is what I call the conversion windfall. Over the next 12 months, virtually all of the 100 plus Canadian income trusts will convert to corporations. As they do, two things will happen.

First, trusts will eliminate the uncertainty that’s depressed their market value since Halloween 2006, when Finance Minister Flaherty issued his infamous proclamation of a new tax in 2011.

Second, they’ll almost certainly beat the extremely gloomy expectations still baked into their unit prices, particularly when it comes to distributions.

Both factors will lift share prices, as demonstrated by the average gain of 35 percent for the 23 that have converted from trusts to corporations already.

The other windfall opportunity is from a growing revival of takeover fever, stoked by trusts approaching 2011 decision time, abysmally low valuations, and a global rush to buy Canada. And, based on the results of the last takeover wave as well as what we’ve seen so far, premiums are likely to range from 35 to 50 percent, some possibly even higher.

The result is a massive windfall for the targets’ investors, for doing nothing other than buying and holding big dividend-paying trusts backed by strong businesses.

Mergers Past and Present

The last wave of Canadian merger mania began in late 2006 and peaked in 2007, resulting in a combined two-year volume of CAD627 billion based on market capitalization. Some three-dozen deals involved income trusts, with premiums to pre-deal prices typically ranging from 30 to 50 percent.

The signature deal was the 2007 offer by Abu Dhabi National Energy Company, known widely as TAQA, for gas-weighted producer PrimeWest Energy Trust. Like all trusts, PrimeWest had taken a hard hit from the Halloween 2006 trust tax announcement, which occurred roughly nine months into a protracted decline in its shares due to sharply falling natural gas prices.

By the time TAQA struck, the units had lost nearly half their value from their late 2005 highs, which were reached in the aftermath of hurricanes Katrina and Rita on the US Gulf Coast.

As a result, TAQA was ready, willing and able to pay a premium of over 30 percent to the then depressed market price.

The thought of a takeover by a government-owned company from the Middle East did arouse some opposition.

In the end, however, the Conservative Party government of Prime Minister Stephen Harper approved the deal, maintaining Canada’s firm reputation as perhaps the least resource nationalist country in the world.

The TAQA/PrimeWest deal closed on Jan. 22, 2008. By that time, however, the “Buy Canada” craze had more than run its course.

For one thing, after more than three-dozen deals, most or all of the willing sellers had been married off. Weaklings were essentially taken under.

For example, the nearly bankrupt Vault Energy was purchased at a discount to net asset value by Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) a week before the PrimeWest deal closed.

Equally important, however, the boom had been in large part fueled by cheap money in the hands of aggressive private capital. UE Waterheater, for example, was acquired at a premium of nearly 50 percent by Alinda Capital Partners in a deal that closed June 29, 2007. But the borrowing power of private capital had all but dried up by early 2008 as the great global credit crunch began to take hold.

Today, most of the private capital outfits that fueled so many deals before the bear market/recession are in dire straits. Even buyouts that involved seemingly ultra-secure assets have been crushed by the debt they took on.

For example, Energy Future Holdings Corp–the privately held company formed from the USD48 billion leveraged buyout of Texas power company TXU Holdings in 2007–is now in technical default.

As a result, they’re unlikely to fuel a new takeover wave. Fortunately, others appear increasingly willing to fill the breach they’ve left and then some.

The biggest deal announced to date involving a trust is a CAD4.1 billion all-cash offer (including debt) from the Korea National Oil Corp to buy out troubled Harvest Energy Trust (TSX: HTE,  NYSE: HTE). To the trust’s long-suffering unitholders, the CAD10 per share offer price feels a lot like a take under and with good reason: It’s basically 40 percent of the net asset value (NAV) of Harvest’s assets in the ground as of their last major assessment in December 31.

In addition, Harvest’s NAV has likely risen since then, as oil is more than 70 percent of output and its price has nearly doubled this year. And that valuation doesn’t even include the refinery business, which contributes on average 20 percent plus of revenue.

On the other hand, Harvest has hardly been a picture of health this year, gutting its monthly distribution by 83 percent. Operating costs are relatively high, refinery margins have deteriorated again and the company is burdened by more than CAD3 billion in debt, more than half of which is slated to mature in 2010.

Put that together and the 47 percent premium Korea National Oil is offering looks pretty good indeed. In fact, it hearkens back to the kind of prices we saw at the peak of 2007 merger mania. And it’s a clear statement of just how aggressive Asian buyers in particular are becoming in their global quest to lock down supplies of natural resources to feed what are now the world’s fastest growing economies.

Another good example is the purchase of 17.2 percent of Teck Resources (TSX: TCK-B, NYSE: TCK) by China Investment Corp (CIC), one of the world’s largest sovereign wealth funds (SWF). Teck’s buyout of the former Fording Canadian Coal–concluded October 31, 2008–left it burdened with CAD13 billion in additional debt.

Like virtually every company completing a major acquisition that year, it was therefore extremely vulnerable to the recession and credit crunch that followed. And as bankruptcy worries crushed its share price fell from a mid-2008 high of USD51 to a low of less than USD3 in early March 2009, it became an extremely tempting takeover target for deep-pocketed and resource-poor Asian firms.

As a Canadian treasure house of everything from metallurgical coal (acquired in the Fording deal) to copper and zinc, CIC’s chances of an outright buyout for Teck were slim. Though it could certainly afford one, indications were such a bold move would almost certainly trigger intense opposition in the public, particularly given the takeovers of other major Canadian mining firms, such as Falconbridge, in recent years. In a worst case, the move would create enormous pressure on Stephen Harper’s government to either quash the deal or impose onerous conditions severely diminishing its economics.

Rather than take that risk, CIC took the far easier route of buying 17.2 percent of the company, while foregoing any attempt at controlling the board. That satisfied regulators, who swiftly approved the deal. It provided needed cash for Teck to finance growth, and it again underscored the takeover attraction of Canadian natural resources, a plus for players across the board.

And resource producers are hardly the only trusts that are increasingly attractive for takeovers. Canadian Hydro Developers (TSX: KHD, OTC: CHDVF) will now never recapture the lofty heights it held in late 2007. But the now-friendly CAD5.25 per share all cash takeover offer from TransAlta Corp (TSX: TA, NYSE: TAC) is nonetheless a 50 percent premium to the price the renewable energy producer held before TransAlta issued its first unsolicited bid. That’s a strong sign of the potential attractiveness of green energy companies, as coal power producers seek emission credits to comply with impending carbon dioxide regulation.

The three option takeover offer from Fluid Music Canada (TSX: FMN) for Somerset Entertainment Income Trust (TSX: SOM-U, OTC: SOEIF) probably won’t strike the latter’s unitholders as overly generous. The cash option of CAD2.12 per share, for example, is barely a fifth of the units’ late 2005 high. It is, however, a 40 percent premium to Somerset’s share price this summer, proving that even weaker fare may be increasingly attractive to value hunters.

In my view, the risks of buying less-than-stellar trusts for takeover appeal far outweigh the potential rewards from an offer. The buyout of PDM Royalties by its parent to form Imvescor Restaurant Group (TSX: IRG, IRGIF), for example, came only after a dividend cut that devastated the unit price. The takeover price not only did not make unitholders whole, but dividends remain suspended pending a new post-conversion payout policy yet to be set.

That’s why my iron-clad rule on buying takeover targets is this: Never buy one that you wouldn’t want to own if no deal occurs. Following that policy will by definition keep you out of PDM-type situations. The good news is that will hardly cut down on your potential profits from what’s shaping up to be a superb opportunity for windfall gains over the next 12 months. And it will substantially reduce your risk.

Below, I examine the top potential takeover bets in each industry I track in How They Rate. The tables highlight them, along with the relevant valuation data. Note that many of the top candidates are also Canadian Edge Portfolio picks.

Energy Heats Up

This week the International Energy Agency (IEA) warned it would be making a “substantial’ downward revision in its global energy demand forecast, declaring conservation efforts would essentially trump the impact of global economic recovery.

Funny thing, the country that’s rapidly becoming the world’s biggest energy hog didn’t seem to buy that.

In fact, the same day the IEA issued its warning, China National Petroleum Corp made a big move to lock down oil and gas resources, announcing a blockbuster pact to develop southern Iraq’s giant Rumaila field in a venture with BP Plc (NYSE: BP).

That’s a pretty clear signal Asian interest continues to grow for global energy resources. Canada is infinitely friendlier to investors than the Middle East.

Foreigners’ target seems to increasingly be the oil sands, where two months ago PetroCanada paid CAD1.9 billion for a majority stake in two Athabasca Oil Sands’ projects, and ConocoPhillips (NYSE: COP) has officially put its 9.03 percent stake in the Syncrude venture up for sale.

Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF), which owns 36.74 percent of Syncrude and is essentially the trading stock for the venture, has been rumored as the likely buyer for Conoco’s piece, valued at an estimated CAD3.6 billion. It’s already increased its position once, locking up 14 percent in a two-deal transaction with EnCana Corp (TSX: ECA, NYSE: ECA) and another 1.25 percent from Talisman Energy (TSX: TLM, NYSE: TLM) in 2007.

Any deal may lead to a higher valuation of Syncrude itself, and by extension Canadian Oil Sands itself. The project, however, is operated by Imperial Oil, a division of ExxonMobil (NYSE: XOM) which owns 25 percent. And given Canadian Oil Sands’ status as a national champion, it’s unlikely to be successfully taken over either.

As a result, the best oil sands takeover bets almost certainly lie elsewhere. Two possibilities are Penn West and Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF). As “Cheap Energy” shows, both sell for less than 60 cents per dollar’s worth of proven oil and gas reserves in the ground.

Both have considerable holdings in the oil sands, though Penn West alone producing there.

Both also have proven their financial and operating strength by weathering the past year, as Penn West’s solid third quarter earnings attest (see Portfolio Update).

And its considerable conventional oil and gas output provides reliable cash flow that could be used to finance major projects, were an acquirer to use it for something else besides funding distributions.

Penn West Energy Trust and Enerplus Resources Fund are bedrock buys up to USD25 and USD20, respectively.

Paramount Energy Trust (TSX; PMT-U, OTC: PMGYF) provides a far less conventional play on the oil sands, by virtue of its considerable landholdings in the Athabasca region. In 2004 and 2005, the Alberta government laid down rules for compensating operators of natural gas wells that are located on top of potential oil sands reserves, which are routinely ordered shut in to facilitate oil sands output.

Last month, Alberta’s Energy Resources Conservation Board (ERCB) concluded that production of gas from 158 wells in the Athabasca region presents a significant risk to bitumen recovery. As a result, it ordered an immediate shut-in of their output, as well as that of several adjacent areas. A final ruling in the matter from ERCB is due in the first quarter of 2010.

Paramount has 70 wells specifically named for immediate shut-in and an additional 18 that may be closed in the final ruling.

That’s roughly 1.9 thousand cubic feet per day (Mcf) of output, taking the trust’s total gas-over-bitumen shut-ins up to 20 Mcf per day, or roughly 11 percent of total output.

How can this be positive? Mainly, the ERCB guarantees royalties as compensation for the shut ins. Paramount, meanwhile, not only saves on capital expenditures and operating costs.

But it retains the right to develop the shut-in wells at a future date when they’re no longer considered a threat to oil sands production.

That coupled with aggressive hedging of natural gas output is what’s kept the trust on track to maintain production and dividends while cutting debt in what’s still an exceedingly difficult environment for natural gas producers. My riskiest pick, Paramount Energy Trust is a powerful speculation up to USD6.

The remaining oil and gas producer trusts in the table are bets on another type of merger entirely: potential consolidation among the producer trusts themselves as the larger ones try to bulk before converting to corporations in late 2010.

Almost all of the trust-on-trust takeovers we saw during the 2007 wave were of acquisitions of weaklings at low valuations. There are still a handful of those around now, notable for their lack of dividends.

In contrast, the majority of those still operating now are battle-hardened. Management may not have decided what to do about pending 2011 taxation. But few, if any, are going to be willing to sell out cheaply for the sake of doing a deal.

That certainly applies to producers listed in the table, including converted corporation Advantage Oil & Gas (TSX: AAV, NYSE; AAV) and four that are still trusts: Bonavista Energy Trust (TSX: BNP-U, OTC: BNPUF), Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF), Pengrowth Energy Trust (TSX: PGF, NYSE: PGH) and Zargon Energy Trust (TSX: ZAR-U, OTC: ZARFF).

Happily, all of them are selling so cheaply now that any offer even approaching the value of their assets in the ground would trigger a windfall gain. Enerplus and Penn West are potential acquirers. So is ARC Energy Trust (TSX: AET-U, OTC: AETUF), which also trades at a discount to NAV and is therefore simultaneously a takeover target as well.

Clearly, there’s no imperative for any of these to join forces. But given the advantages of scale in this business and the fact their favorable tax status is about to go away, there’s also a powerful incentive to do so. And best of all, all of them are compelling buys at target prices listed in How They Rate whether there’s a deal or not.

For more information on their fundamentals, see Oil and Gas Reserve Life.

Green Power

TransAlta may not be paying top dollar for Canadian Hydro. But the price it did pay of 1.55 times book value is nearly twice the current valuation of now converted corporation Algonquin Power & Utilities (TSX: AQN, no US symbol yet). And it’s nearly that for Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF).

Both companies specialize in carbon neutral energy and would therefore be of great help to any acquirer in need of emission credits. Boralex’ most likely suitor would be its parent Boralex Inc (TSX: BLX), which owns more than 20 percent of its units and operates its plants. In fact, it could wind up being part of an even larger deal involving its parent, which itself trades at only 90 percent of book value.

In the trust’s third quarter conference call, Chief Financial Officer Jean-Francois Thibodeau stated management is “evaluating” its options for a future corporate structure but “as far as we are concerned there is no immediate need for the fund to either consider conversion or any other decision.” He also asserted that the fund has “the capacity” to postpone a decision until 2013.

Meanwhile, third quarter earnings were generally solid, as management executed on a series of cost savings from its wood water power operations, offsetting somewhat the continued closure of the Dolbeau woodwaste plant. Cash flow–down 4 percent from last year’s tally–was also helped by much better output from the core hydroelectric plants. The payout ratio came in at 107 percent, due to negative cash flow from wood waste power operations.

Looking ahead, maintaining the current level of distribution depends heavily on getting some kind of deal with Dolbeau. And there apparently haven’t been new developments since the tentative deal last month with waste supplier/power off taker Abitibi Bowater.

At the current price, however, Boralex is still certainly pricing in much worse news, even as the portfolio remains solid. As for Algonquin, it has now made the leap from trust to corporation. Former unitholders should now have received one share of the new company for every unit of the trust they once held.

The monthly dividend of CAD0.02 per share remains unchanged, with the next payment due November 16.

As for the company itself, third quarter cash flow came in at CAD20.3 million, slightly off from last year’s CAD22.2 million but above second quarter levels. Lower energy prices were the major reason for the shortfall.

Distributions, however, were solidly covered (payout ratio 38 percent of nine months cash flow), the balance sheet remained strong (debt cut 6.3 percent over the last 12 months), assets performed well across all divisions and management continued to execute on its asset expansion, including the joint acquisition of a California utility with Emera (TSX: EMA, OTC: EMRAF).

Algonquin’s current revenue split is roughly 60 percent US, 40 percent Canada. That ratio will move even further to this side of the border when the Emera venture utility purchase is completed in early 2010, making it even more attractive for a takeover even as it shelters more cash from Canadian taxes. Algonquin Power & Utilities and Boralex Power Income Fund are buys up to USD5.

Slightly larger Innergex Power Income Fund (TSX: IEF-U, OTC: INGRF) is also slightly more expensive than those two, selling for 1.5 times book value.

It is, however, a considerably higher quality situation and, moreover, a pure play on carbon-free energy at 73 percent hydroelectric and 27 percent wind.

Over the past several years, management has consistently built and bought assets that have grown cash flow, and it’s on the lookout for more. Its 240 megawatts of renewable energy capacity look increasingly like a major price in a carbon constrained world.

And in the meantime, it enjoys a guaranteed market in Canada with built-in rate increases. Innergex Power Income Fund remains a solid buy up to USD12.

I review prospects for fellow Conservative Holding Brookfield Renewable Power Income Fund (TSX: BRC-U, BRPFF), the former Great Lakes Hydro, in this month’s Portfolio Update. It’s likely to be an even bigger beneficiary of growing demand for green power, though 51 percent ownership by parent Brookfield Asset Management (TSX: BAM-A, NYSE: BAM) could be a bridge too far for would-be acquirers.

At Energy’s Service

Far more than even oil and gas and other natural resource producers, energy services companies and trusts have suffered greatly during the Great North American Recession. With the cut by Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXHF) last month, every single sector trust and corporation tracked in How They Rate has now cut its distribution at least once in the past year. Three of the eight no longer even pay distributions.

Energy services companies and trusts’ basic business is to rent drilling rigs and other equipment to the oil and gas production industry, as well as provide a range of services including catering. During boom times, demand for their equipment and services soars. Revenue rises on the volume of business, as well as on higher rents they can charge for their equipment and services.

That’s basically what happened from early this decade up to middle of 2008. Since then, the sector has been caught in a powerful downdraft. Low energy prices have triggered a massive shutdown of drilling across North America. That’s reduced demand for energy services and drilling rigs, idling capacity. And that’s forced sector companies to reduce rents for equipment and fees for service.

Here in late 2009, we’re seeing some signs that drilling is picking up. That’s certainly not reflected in the earnings for the three energy services companies on our list: Cathedral Energy Services Income Trust (TSX: CET-U, OTC: CEUNF), Phoenix Technology and Aggressive Holding Trinidad Drilling (TSX; TDG, OTC: TDGCF). Cathedral and Phoenix are reviewed in Dividend Watch List, while Trinidad’s results are highlighted in the Portfolio Update. But it is a good sign for the future.

More important, while they may indeed have to suffer though an energy patch slump for a few more quarters, all three are in good position both to weather hardship and to profit from the eventual recovery. Mainly, despite bad conditions, all remain profitable.

None are laden with debt. Their equipment employs the latest technology. And they’re focused on long-term deals with very creditworthy customers operating in the areas of highest potential. That’s basically shale gas and other deposits requiring non-conventional drilling techniques.

At this juncture, the North American energy services industry remains widely dispersed. A number of companies, however, have begun to take an interest in consolidation, including giant Canadian trust Precision Drilling (TSX: PD-U, NYSE: PDS). That doesn’t ensure a deal for any of these companies. But all three are certainly prime candidates and, at modest valuations now would command a hefty premium.

As their share price volatility and dividend cuts have shown over the past year, these are not suitable holdings for conservative investors. But for those willing to live with the risk, all three have massive potential, both on their own and as targets.

Property Values

For most of the credit crunch/recession, opportunities for vulture investors in commercial property have been relatively scarce. That’s been especially true in Canada, where aversion to excessive debt and sound banking practices prevented the hyper-leveraged buying frenzy and subsequent bust that occurred in the US.

For example RioCan REIT (TSX: REI-U, OTC: RIOCF), Canada’s largest commercial REIT, earned less cash than its distribution in the third quarter, as it was unable to deploy a cash hoard of CAD300 million earmarked for acquisitions fast enough. It consequently lost out on the spread between basically zero deposit rates and its low cost of capital.

The good news for RioCan now (see Portfolio Update) is targets are starting to appear, evidenced by the heavy investments it made in accretive acquisitions in the third quarter. Unfortunately, for the sellers, the prices it’s paying aren’t pretty. And the longer the North American property market takes to recover, the more dire will become the plight of distressed owners, and the lower selling prices could fall.

That dynamic makes it very difficult to highlight takeover plays in the Canadian real estate investment trust sector. In fact, we’re already seeing one definite take under, as IAT Air Cargo Facilities Income Fund (TSX: ACF-U) moves in on nearly bankrupt Huntingdon REIT (TSX; HNT-U, OTC: HURSF) in a share-for-share deal. Huntingdon unitholders have no real choice but to vote for at or before the scheduled November 26 meeting.

Huntingdon’s woes are shared by several other sell-rated REITs in How They Rate: They invested like Americans during the boom, piling up too much debt and paying too much for properties in a bet that growth and prices would continue to rise. Now they’re paying the price, and investors should continue to stand clear.

One notable exception is Artis REIT (TSX: AX-U, OTC: ARESF). At first glance, the REIT would seem an obvious choice for a crack-up, given its rapid growth of recent years and heavy concentration in resource-dependent Western Canada. That’s certainly what many investors assumed, selling units off from the mid-teens as late as September 2008 to an eventual low of less than USD4 in December.

Since then, however, Artis has proven again and again how foolish it is for investors to judge a book by its cover. We won’t have third quarter earnings until November 11, but indications are they’ll again be solid, thanks to management’s long-term refusal to overly rely on debt and a portfolio of high-quality properties that’s still charging below-market rents, even in hard-hit markets.

The REIT’s sale of a Calgary office property for a CAD4.4 million gain last month is about as clear a sign as possible that its properties are staying above the energy patch meltdown. Meanwhile, management continues to diversify its portfolio against further trouble in Alberta, deploying the funds to the purchase of a flex-industrial property in Winnipeg with a 92.3 percent occupancy rate in the middle of a deep recession.

The sold Calgary property also accounted for 40 percent of Artis’ expiring leases for 2010 in the city and 5 percent of expires portfolio-wide. That should dramatically improve visibility of 2010 profitability, another big plus.

Artis units have come well back from their lows this year with a total return of more than 50 percent. But selling for less than book value and a yield of more than 11 percent that’s consistently been well covered by funds from operations, it’s hardly expensive.

And it’s precisely the kind of property that a larger player should want, particularly as a safe way to beef up west Canada exposure. Buy Artis REIT up to USD10 if you haven’t already.

Recession-Proof Growth

The remaining three companies in “Low Valuations” hail from a range of industries but have several key strengths in common. They’re cheap, dishing out double-digit yields that are well protected with recession-resistant cash flow and selling for modest multiples to book value. All have continued to grow their businesses in the worst possible conditions. And none of them have any significant debt maturities due until at least 2011.

Converted corporation Colabor Group (TSX: GCL, OTC: COLFF) is reviewed along with its third quarter results in the Portfolio Update. Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF) is a High Yield of the Month selection and a new Conservative Portfolio addition.

The third, FutureMed Healthcare Income Fund (TSX: FMD-U, OTC: FMDHF) dominates a market where demand is perhaps the least elastic and hence recession resistant in North America: nursing home supplies, including specialty furniture, incontinence and wound care products and medical diagnostic equipment.

We won’t have the trust’s third quarter earnings until November 11. But based on what’s happened so far during the recession, there’s little to worry about, as demand for existing products has remained steady and management has found new avenues for growth as well.

The trust has yet to announce what it will do in 2011. But trading at just 1.09 times book value and yielding nearly 11 percent, the bar of expectations has been set very low. And that’s generally a good prescription for future capital gains, even if there is no lucrative merger offer coming. FutureMed Healthcare Income Fund is a first-rate buy up to USD10.

This is far from an all-inclusive list of Canadian trusts and corporations with takeover potential. I’ve left out a good number of names I didn’t feel measured up to a high standard for quality. And in fact weaker fare did make up a large percentage of acquired trusts in 2007.

On the other hand, as we’ve seen again and again, there’s really no substitute for strong underlying businesses. You may get lucky buying something of inferior quality on the basis it may be taken over. By and large, however, that strategy will bring you nothing but an empty wallet.